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Jun Yan

Cash vs accrual accounting: a guide for Aussie SMEs

By Business Advice No Comments

In business timing is everything, especially when it comes down to the basics of how you manage your money.

In accounting terminology, SME owners have the option to manage their business finances either on a cash basis or through accrual accounting.

These are both very important to understanding your business fundamentals.

As we will explain, accruals accounting can help business owners feel more at ease than reporting on a cash basis.

The reason is that the former provides a better picture of what the underlying business is doing rather than just tracking cash in and out, which often doesn’t reflect the performance of the business. Cash accounting means your performance could be overstated or understated depending on when you’re looking at your accounts.

What’s the difference?

The difference between cash and accrual is in the timing.

Cash basis accounting is used when you recognise the money only once it has changed hands, put simply, when it is in or out of your bank account. That means looking at expenses when they are paid, and invoices when the money comes in.

By contrast accrual accounting recognises your performance, by tracking revenue when it is earned and expenses when they are billed – regardless of when they are paid.

So what happens with a lot of small businesses?

Cash is often the default method used by SMEs, especially those on the smaller side, as it is the minimum requirement for quarterly reporting purposes, and it is also much simpler to manage.

But that doesn’t mean it’s the right thing to do. While simplicity is a good thing, it can come unstuck as business owners may lose sight of the underlying business performance.

The benefit of modern accounting systems like Xero or MYOB is that it is now easier to manage both (accruals and cash) so you get the best of both worlds – reporting on a cash basis but still being able to see your performance and position. However, it is still essential to have a good understanding of what each means.

A case study:

Olive, who is a small sporting goods retailer, buys 100 sets of skis over a three month period (x50 in April, x25 in May, x25 in June). She sells them for $200 each (x30 in May, x50 in June, x10 in July and x10 in August)

The difference between cash accounting and accrual accounting is displayed in the table below.

The key difference is the timing of when the cost of goods sold is accounted for. As you can see, in the ‘cash accounting’ method, the cost of goods sold is accounted for as soon as they are purchased and paid for however in the ‘accrual accounting’ method, the cost of goods sold is accounted for only when the goods are sold. As a result, the ‘accrual accounting’ method provides a more accurate reflection on the business’s performance where as the ‘cash accounting’ method focuses purely on how much cash is moving in and out of the business and not necessarily how the business is performing. Another thing to look at is how the profit margin (profit/sales) is reflected in each method. Olive’s business is purchasing skis at $100 and selling them for $200 each. That is a 50% profit margin however, when you look at the scenario from a ‘cash accounting’ perspective, the profit margin appears to fluctuate every month but that is not the actual case.

There are flow on effects to broader business management no matter which you take. Let’s take a more in-depth look at both.

Cash accounting

Cash accounting is a simple method of bookkeeping that keeps track of the cash coming in and out.

How it works:

  • Expenses: when you get an invoice you don’t record the cost till it is paid
  • Revenue: you don’t record revenue until you have the cash

The pros are:

  • Simple to maintain
  • You can see easily when something is paid or charged
  • You can report GST on a cash basis
  • You can see how much cash your business has at any given time

Challenges:

  • You can’t see money you owe to people, or they owe to you
  • There’s no visibilty on performance… *

*If we refer to the above case study, at the start of the season it appears that the business has performed terribly on a cash basis – ordering stock, but once it makes a sale then it is likely to have improved its cash position. However, this position then neglects the fact that it will still have stock on hand, impacting the profitability of trade.

This would suit:

Businesses which have an instant fee for services such as hairdressers or small takeaway restaurants. However, these will still need to account for payroll tax, GST and other legal obligations.

Accrual accounting

Accrual accounting is a more complicated method of accounting, and you may need to get external assistance to help.

It means you record expenses and sales when they take place, rather than just the cash transactions, which means you can keep track of who you owe money to, and who owes money to you.

The pros:

  • Tracks your true financial position as it accounts for outstanding expenses or invoices
  • Helps to better understand financial performance (smooths out things like inventory orders) or delivery of work over time etc.
  • Helpful in accounting for large contracts or upfront expenses

Challenges:

  • It is more complicated and likely to mean you need to rely on a professional such as an accountant or experienced bookkeeper

This would suit:

Ideal for businesses that do not get paid immediately such as tradespeople, retailers, wholesalers, or a consultant who invoices at the end of a project etc.

How to pick a method

To choose the method right for you, ensure you understand how your business works and what you need to accommodate for.

You might want to consider:

  • The size of your business
  • Complexity and timeline of your transactions and processes
  • Whether you have the resources to manage more complicated accounting
  • Whether there are likely to be reporting requirements
  • Future needs including funding from banks or other lenders. Having accruals accounting will help to improve the demonstration of sophistication of accounting practices and improve the business’s likelihood of being granted funding.

As always, a great first step is to speak with your accountant about whether you need to consider a different way of managing your business finances.

Stability amid the coronavirus crisis: Lessons from Parallel Workshop Architects

By Interview No Comments

When the economic effects of the global coronavirus pandemic hit Australia, Melbourne based architecture firm Parallel Workshop Architects went back to business basics. 

They’d experienced the effects of uninformed decision making in the past, dealing with the costs of high growth, and didn’t want to make similar mistakes again. 

Founders John Xu and Max Bi saw the global job losses, business uncertainty and could see the scale of the impact the crisis was likely to have. 

“It was like everyone just got hit in the face,” Bi says.  

Calm in the face of coronavirus crisis 

Instead of reeling from the shock, the team sat down to look at the state of their business, consulting their custom Ravit Insights financial models. 

Xu and Bi use a three speed model, consulting one daily for business as usual activity, another each month to see how the business is tracking in a 12-month time frame, and the third reviewed annually to assess where the business needs to grow and expand.  

In response to coronavirus, they went through the model looking at their business pipeline, assumptions and cash buffer, checking expenses compared to revenue and made scenarios to plan for what could happen as the crisis continued.  

“This was a key meeting that we had,” Bi says. “It stabilized us and allowed us to give stability to our team, which will help with productivity and maintaining focus in our business and our staff. We were also able to see whether or not we’d be eligible for government stimulus packages. 

“With so many factors out of our control, it is unclear for us how we’d deal with this unprecedented situation or run our business without this model. Basically, we’d be panicking. 

“We have a couple of months runway which will take us into next financial year working through business as usual, but from home. We’ve also set certain triggers that will ensure we’re prepared if our business circumstances begin to change.” 

Guided by values 

That an architecture firm was so focused on maintaining a stable financial position is not an accident.  

“We’ve both been employees, been in a recession in the GFC and dealt with the fickle nature of some business leaders. 

“Which is why when we started our business we had three core values that we still hold as our guiding principles: Value – to our clients, Family – ensuring our staff are treated well and finally Responsibility – to be in control of our business,” Bi says. 

“The latter means that we have always considered it our responsibility as business owners to understand our financial responsibilities to protect our staff, clients and ourselves. I can build a big or a small brand, but those who help us, those people are what’s important. 

“We have a fast-growth business, so getting a financial model to understand that growth and how business operates has been essential.  

Residential development by Parallel Workshop Architects

“We didn’t always have that. The first big phase of growth saw our business go backward because we didn’t manage our resources properly. The founders were working too hard and it took us too long to bring in support.” 

Preparing for the unknown 

Without clarity on coronavirus, the Parallel team is sticking to what it can control, using the model as a guide on how to approach the coming months. 

“We have key projects we’re working on now, and are working hard to ensure these remain stable,” Bi says. 

“The small changes are easily managed as we know through our model that we can forfeit profit or cut some expenses, because we know that our team is the most important part of our business to maintain.” 

But they will need to deal with the change in business and economic climate. 

“Right now we definitely see a slow down in new business, but there will be a lot of people looking for opportunity when the economy starts to recover,” Bi says. 

“We know that we are stable, and, again thanks to our model, we have clarity on the length of the business development cycle and what we need to consider in the coming months. 

“It’s unlikely we’ll get much broader certainty over the coming months, but it is comforting to have the processes in place to give our team and business as much stability as we can.” 

More on Parallel Workshop 

Parallel Workshop Architects is a Melbourne-based boutique design house specialising in architecture and interior design, creating spaces that enhance lifestyle and experience. 

As an emerging studio of passionate creatives, our commitment is to provide a bespoke approach to every project, delivering an identity while maintaining value to each unique design. 

With an enthusiasm in contemporary design, the PWA team challenges the status quo by merging technology, space and modern living into design approach. 

Residential development by Parallel Workshop Architects
Private residential project by Parallel Workshop Architects
‘Wonder Bowl’ interior by Parallel Workshop Architects (Photographed by Peter Benetts)

Beyond Government subsidy: How to keep your staff employed

By Business Advice, Journal entry No Comments

As a business owner, being in charge of your staff’s livelihoods is a responsibility that can lose you sleep, even in boom times.

In the current climate, with many businesses reeling from revenue or business model hits due to the Covid-19 pandemic, keeping people in jobs is a genuine crisis.

The Federal Government has released a wage subsidy of $1500 a fortnight per employee with the aim to keep thousands in work during a time where we are in “social hibernation”.

Through our financial modelling, we help businesses understand what will happen in varying situations.

For many industries, hospitality, fitness and retail, dealing with such a sharp decline in revenue is almost unprecedented.

To keep businesses operational or even viable in “hibernation”  there are a few solid strategies that can help and hopefully keep staff on board through the hard months.

Can your business access the JobKeeper subsidy?

Businesses and sole traders with revenue under $1 billion will be able to access the JobKeeper subsidy of $1500 a fortnight to support employees if their revenue has fallen by more than 30 per cent (of at least a month).

The Government has also introduced discretionary measures to allow for pre-revenue, high-growth and businesses that have not been in operation for a year.

The best resource to keep up with changing information for these and other measures is direct through Government websites. We also recommend contacting your accountant for more information specific to your business.

Cut costs

Depending on how the current economy has affected your business there are probably areas that ordinarily would be considered essential that must be cut at least temporarily.

Redeploy: If you are a larger business, you might be able to move staff into different roles where more help is needed.

Leave: Other businesses are reacting by asking staff to take periods of leave, both paid and unpaid, through the pandemic period to balance their cash.

Re-negotiate terms

It is essential during these months of uncertainty to assess whether your business has a cash flow, revenue or other problem.

If it is cash flow related, speak to suppliers and other stakeholders about different terms to cope through the pandemic.

One area under focus is commercial rent with landlords moving to defer rental payments. Some co-working spaces, including the one we are based in Stone&Chalk, have offered three months rent reprieve to assist businesses through the crisis.

Flip your business

If we told you a month ago, that Attica, one of the world’s 100 best restaurants, would pivot into a bakery to survive, you’d have laughed at us.

But it has, and many other strong brands in the restaurant business have likewise flipped their models to survive through an uncertain period.

Many of us can look to these savvy business owners for inspiration on how we can change and adapt to the rapidly evolving situation.

But keep your eye on the future, a crisis can push a business to change in positive ways and ensuring you think long-term will help ensure you make the right choices now.

Charles Darwin said it best: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”

Keep communicating with your team

In this period of social distancing, keeping connected to your team is important. You don’t want to lose good staff through lack of support as they’ll be essential to your recovery when things begin to pick-up again.

Although a time of uncertainty, giving your team updates to keep business progressing, and the team informed about their potential job security will help not only producitvity, but their personal wellbeing.

There is no doubt that no matter what your business is, it will be a time of evolution and change. Before making major decisions it will pay off in the long-term to return to your key business drivers and fundamentals.

We also have responsibility, and now incentives, to keep our teams together and staff employed where we can through the Covid19 crisis.

Understanding where your cash flow and growth has come from in the past, and where it is likely to pick up when the economy begins to recover will help guide your choices so they are beneficial to your business now, and when the good times come again.

Why the federal government’s coronavirus stimulus package won’t save your business

By Journal entry No Comments

The federal government’s stimulus package won’t save your business. 

Increasing the instant asset write-off threshold, as well as some money to help keep staff on board, will be helpful, but as we see a panic-driven economy reeling from uncertainty around COVID-19, these are not measures that will prevent closures.

As a tax incentive, they also rely on businesses having the cashflow upfront to spend money regardless. 

In fact, while these measures are designed to encourage spending and growth to stimulate the economy, this is may not the best time for most SMEs to do so. 

Before considering even trying to take advantage of this package, business owners must rely on their fundamental systems and practices, and crucially, understand how this market will affect their revenue. 

However, first, don’t panic. 

SME owners can’t afford the panicked equivalent of a run on toilet paper. 

To survive you must avoid making panic-based decisions, and at the same time, keep your head out of the sand. 

So take a moment to step back calmly as there will likely be impacts on most businesses, and there are things everyone can do to protect themselves.

Understand your business

All business owners should understand the levers and drivers that keep their companies going. 

If you work in travel, or have a restaurant catering to the Asian tourist market, you would be right to be concerned about the impact the coronavirus will have on your revenue. 

Flight Centre has had to continuously reduce its full-year profit guidance (the amount it tells the stock market it is expected to profit) and managing director Graham Turner has said reducing costs is a priority along with a return to business as usual as soon as possible.

“Within this uncertain environment, our priorities are to reduce costs, while also ensuring that we and our people are ready to capitalise when the steep discounting that is underway across most travel categories starts to gain traction and as the trading cycle rebounds,” Turner said.

However, other industries may be affected differently. If you work in IT services or cyber security, there may be increasing demand for your services as many professionals opt for increased remote working. 

The key is to be aware and try to understand how and why your business may be affected.

If you are affected

In a perfect world, all businesses would hold 12 months of cash to underpin operations, but there are many different arguments and realities. 

I recommend that you understand your business’ cash cycle and have a contingency plan so you can last for at least a quarter (three months) with no revenue. 

Many small business owners take money out of their business straight away, not leaving enough of a buffer on the balance sheet to ride out a downturn in circumstances.

The essential thing to do is to focus on your business fundamentals.

Make sure you keep doing business

This sounds basic, but whatever your business does, keep doing it. Don’t get stuck in the hype and act irrationally. 

Don’t scapegoat coronavirus

It is important to budget correctly, analyse variance and understand if any issues are actually being caused directly or indirectly by the coronavirus.

It is sometimes easy to find a scapegoat when things are going wrong, but what you might find is that there could be underlying problems within your business. 

Strong businesses will be able to withstand down periods in a market.

Focus on pipeline and growth

If the current state of the economy could affect your pipeline, then you will need to pay more attention to it. If you’re likely to win less business, you might need to work even harder on attracting it. 

If there’s a dramatic impact on business, do you have a balance sheet strong enough to withstand it? And how long can you withstand it for?

Communicate with staff

Uncertainty is what’s caused the great toilet paper panic. 

Don’t let that happen in your business. Be open, clear and communicate with your team about any extraordinary measure you’ll need to take. 

You want to give confidence that any measures are short term. It is unlikely this pandemic and associated uncertainty will go on forever. We need to be patient in the interim, and still be ready to ramp up back to business as usual. 

If your revenue will be hit

In a downturn, your revenue might take a hit. If that is likely to happen to you, be realistic. 

Be aware of what is happening, and pay attention to who is impacted by the coronavirus, what the World Health Organisation’s advice is and even what broader public officials are saying. 

As an example, with public events such as the Melbourne Grand Prix being cancelled, more are likely to follow. That means if your business is in hospitality, travel and even retail, you will see an impact. 

The Grand Prix was cancelled last minute, but business owners should begin planning contingencies for other major events in the coming months. 

Emergency measures

If you really run into cashflow trouble, you may need to take some action. 

Leading from the front, Qantas’s CEO Alan Joyce is taking a $3.3 million pay cut as the airline has slashed international flights by 90% for the rest of the financial year. 

Flight Centre has taken action to close stores and where possible put staff on leave without pay to avoid having to cut jobs. 

If you are across the fundamentals, have taken appropriate measures to cut costs, and understand your budget variances, all this leads to a better conversation with financiers if it comes down to the crunch. 

Financial health check: Why you can’t manage your business by your bank account

By Business Advice, Uncategorized No Comments

 

It’s the start of the year, and in these early days, it’s natural to take a look at how your business is going financially. The unfortunate thing is that this step is often where SMEs make their biggest mistake. They look straight at their bank account and that’s it. I’m guilty of this too, and in Ravit Insights’s dealings with a wide range of companies, the same holds true for other owners.

We too frequently take the shortcut of looking at how much cash is in the bank to guide key decisions. When running a business it can be very easy to get caught up in the day-to-day operations and looking for shortcuts like this one can land you in trouble.

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3 years on…

By Journal entry No Comments

Happy new year and welcome to 2020!

Before I start, I’d like to draw attention to the fact that while most of us are celebrating the new year, the country’s serious bush fire crisis is ongoing. I wish all the firefighters and other emergency services well and thank you all for your service. We encourage everyone to join us in a show of support by donating, no matter how big or small, to help support and provide some relief to these brave volunteers.

Click here to make a donation to the CFA for all their hard work and bravery

2019 in review…

When I started this venture back in 2017, I set out on a new challenge, and it was an exciting time.

Three years on, the excitement remains, but for vastly different reasons. In the three years since, there has been significant changes to the business with lots of learning and experiences – both highs and lows.

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’tis the season – so is your business prepared?

By Business Advice No Comments

For most Australians December is either a time where your foot is flat to the floor, or you’re winding down and focusing on the next end of year lunch.

Knowing which camp you fit into is vital for all Australian small and medium businesses.

For the gelato store near St Kilda beach in Melbourne a warm summer with more tourists and beach days can make their business profitable for the entire year, even through the dark days of winter. The same goes for the retail stores, which despite declining economic environment, often rely on a very busy Christmas to buoy their annual turnover.

However, for others, like consulting firms or those in financial services, December signals a time to wind down. Often businesses will really slow down over late December and early January, with some taking a much needed break.

Whichever camp, or another, you’re in, it is important to understand how seasonality will affect you.

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Why growth is bad for your bank balance

By Business Advice No Comments

Growth is good. But it comes with big challenges.

With the hype in the startup world, growth, in the form of a mythical hockey stick, has become one of the much vaunted and sought after business metrics.

As we frequently see reported globally, the highest growth and highest valued technology startups are rarely profit or cash flow positive – think Uber and WeWork.

What that means for the majority of business owners, is that balancing growth with cash flow or capital needs is one of the key operational challenges.

It’s probably what you’ll lose sleep over (if this is you, take a breath and fill out our growth early warning signs check list).

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Don’t listen to billionaires — they don’t understand your business

By Business Advice No Comments

When we started Ravit Insights, we followed advice from billionaires and industry experts by putting ourselves in front of potential clients and this is what it got us: radio silence. The truth is, billionaires and experts don’t have a full understanding of our company, and they don’t have a full view of yours either — despite what they would have you believe on LinkedIn and Instagram.

They got to their high level of success over a long period of time, and they’ve probably forgotten half of what they’ve done to get there.

The mistake we made was taking their words at face value rather than thinking for ourselves. Following their advice, we priced our solution too high, and we didn’t go anywhere. Instead, we needed to educate ourselves and find people who truly understood what we were trying to achieve and at what scale and pace.

We could have had a lot more clients if we had ignored the experts and trusted our gut straight away. This is the advice we wished we had been given two years ago.

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Contact us today at info@ravitinsights.com.au